Derivative Trading

Derivatives are financial instruments with no independent value of its own. The value of such securities is derived from the underlying assets like stocks, bonds, commodities, currencies, etc. They were initially developed for hedging but now account for two-thirds of total transactions globally. The two popular derivatives products traded in India are futures and options.

Yes, a company can buy and sell derivatives securities without registering itself as an NBFC. The NBFC (Non-banking Financial Cooperation) is an entity involved under the principal business of acquisition of shares/bonds, advancing loans, insurance business, trading in marketable securities, etc. If any company is not registered as NBFC under Companies Act, 2013, that means their principal business involves agriculture, industrial activity, trading of products (other than securities), providing services, or property dealing.

No, stocks and derivatives are different securities while highly allied. The stock prices are derived from the supply and demand of the particular share, while the derivative prices are derived from that of the underlying. While the stocks are independently priced, the derivative is dependent. Basically, derivatives are the contracts between two parties whose price is determined by the underlying asset (like stocks, bonds, interest rates, etc).

With a different type of derivatives product, the pricing mechanism is different for each variant. The one thing similar to all of them is the fact that their pricing depends on the underlying instrument. The pricing of a futures contract depends on the spot price with the basis point. While that of an option contract depends on the time, volatility, and strike price.

Initially, derivatives were used only to hedge the positions but now they are a major part of the investor’s portfolio. Whether or not you should trade in derivatives depends on the like risk appetite. The derivatives provide huge exposure with a small capital emerging it to be a double-edged sword. Hence, if you can manage the risks associated and yield enough returns, this instrument is for you.

The derivatives are sometimes interchangeably referred to with futures or options contracts in India. In origin, they are the types of derivatives contract which are mostly traded in the Indian market space.

The derivatives trading was widely developed post-1970s when the financial market’s stability was questioned. While the usage of this instrument was not prevalent in India until June 2000. Such products impact financial space because of several benefits. o Helps in hedging your position effectively. o Access to huge exposure with a limited amount. o Helps in determining the price of the underlying security. o Helps in increasing the efficiency of the financial market. o Access to otherwise unavailable assets. o For speculative purposes.

The non-financial entities use derivatives to mitigate the risk that arises from the unexpected rise or fall in the product prices they deal with. For example- if a Basmati rice distributor has entered a future contract with the farmer to buy the product at a pre-specified rate at a later date then the company has mitigated price fluctuation risks.

The derivatives can be used to mitigate and manage risks when it comes to investors as well as companies dealing in the underlying. The investors look for the option to yield return while protecting any unforeseen risk by hedging with derivative products like futures or options. While the companies dealing in the underlying like commodities, manage risk by fixing the prices beforehand.